How to Turn $1,000 Into $271,201

If Benjamin Graham is the father of value investing, T. Rowe Price -- the man, not the firm -- is the inspiration for growth investors.

But few of us will ever practice the strategy as well as Price did. One thousand dollars invested in 1934, when he first unveiled his "model growth stock portfolio," would have become $271,201 with dividends reinvested by the end of 1972. That's a 15.9% average annual gain over 38 years!

How he did it
Price succeeded because he bought the best firms before they became widely known. Quoting from John Train's Money Masters of Our Time, "Even the amateur investor who lacks training and time to devote to managing his investments can be reasonably successful by selecting the best managed companies in fertile fields for growth. "

For Price, the best-managed firms sported several attributes. Among the list:

  • Superior research to develop products and markets.
  • Lack of cutthroat competition.
  • Comparative immunity from government regulation.
  • Low total labor costs, but well-paid employees.
  • At least 10% return on invested capital, sustained high profit margins, and superior growth of earnings per share.

Price would find several huge winners by following these criteria. Among his biggest was toolmaker Black & Decker (NYSE: BDK  ) , which returned 14% annually by rising from $1.25 to $108 a share over 34 years in the portfolio.

Applying the Price method to today's stocks
What would Price invest in today? Knowing what we know about how per-share earnings can be manipulated, I am going to substitute revenue growth for earnings growth. But all of Price's other criteria, for my money at least, are timeless.

Here then is a short list of stocks that have grown revenue by at least 25% over each of the past three years, that sport double-digit returns on capital, and which take in 30% or more of sales in earnings before interest and taxes (EBIT):

Company

Three-Year Annualized
Revenue Growth

ROC

EBIT Margin

Actions Semiconductor (NASDAQ:ACTS)

212.9%

27.7%

44.6%

LoopNet (NASDAQ:LOOP)

66.5%

23.8%

46.7%

Swift Energy (NYSE:SFY)

41.8%

16.4%

47.2%

Travelzoo (NASDAQ:TZOO)

56.9%

43.6%

42.8%

Vaalco Energy (NYSE:EGY)

40.5%

42.7%

76.7%

Source: Capital IQ, a division of Standard & Poor's.

But few stocks will ever meet all five of Price's criteria, including some of those that passed our initial screen. Travelzoo's travel-deals newsletter, for example, faces competition from every travel agent in the country and all of the online booking engines.

Then there are both Swift Energy and Vaalco Energy, which, as oil and gas explorers, are cyclical businesses that also happen to be susceptible to federal regulation. They're probably not stocks to hold for decades.

Conversely, firms that sport technical advantages often make for wonderful long-term holdings. That may be what we have with Actions Semiconductor, which makes highly desirable systems on a chip for MP3 players. Those following the stock in our Motley Fool CAPS investor-intelligence database have named it one of their 10 best.

Still, I wonder whether Price would agree. MP3 players are no doubt hot right now and probably will remain so for many years. But Actions is merely a designer. It doesn't actually manufacture chips. What if a rival created a better design? What's to stop an Actions customer from switching? I've no idea.

Which, finally, brings me to Motley Fool Rule Breakers pick LoopNet. Commercial real estate may be a tough game, filled with tough competitors, but no one else has created a digital marketplace for commercial property that's also vetted by users, as LoopNet has.

And it's a winning approach. In the recently completed fourth quarter, sales were up 52% over last year. Earnings before interest, taxes, depreciation, amortization, and stock-based compensation were up 93% over the same period. Management, meanwhile, increased guidance for 2007 and holds more than 35% of the outstanding shares. They'll get rich when investors and front-line employees do, just as Price would have preferred.

Follow in Price's footsteps
If Price teaches investors anything, it's that the best value stocks are often bought as early-stage growth stocks. For David Gardner, investing in growth has produced a decade of 20% real-money returns and, with Rule Breakers, four stocks that have more than doubled in the first two years of the newsletter service.

Could you duplicate that sort of performance? Price thought so. If you're ready to take your shot, accept our invitation to a 30-day free trial to Rule Breakers. Our newest issue comes out today, so come and see which stocks we believe are the misunderstood multibaggers in the making.

Fool contributor Tim Beyers is a sucker for growth stocks and a regular contributor to Rule Breakers. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. The Motley Fool's disclosure policy thinks you're good enough, smart enough, and, doggone it, people like you.


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